October 2017

Financial Guidelines for Agriculture: An Implementation Guide for Non-Accountants

In order to avoid misunderstanding among members of the accounting profession relative to potential

conflicts between current generally accepted accounting principles (GAAP) and the farm financial

analysis recommendations contained in this report, the Farm Financial Standards Council issues the

following statement:

The Farm Financial Standards Council (FFSC) recommendations are

not written to suggest changes to GAAP; nor should they be construed to serve as a replacement for, or an alternative to, GAAP. In fact, the FFSC recognizes that financial statements prepared in accordance with GAAP may be the ultimate goal for agricultural producers. Currently, however, many producers do not maintain their financial records according to GAAP. It is for these producers—and the lenders, educators, and advisors who work with them—that our recommendations on financial reporting are prepared.

Reproduction or translation of any part of this work beyond that permitted by Section 107 or 108 of the 1976 United States Copyright Act without the permission of the copyright owner is unlawful.

Members of the Farm Financial Standards Council, who serve without compensation, are persons interested in improving the quality and meaningfulness of financial reporting and financial analysis for all agricultural producers.

The material set forth in this publication is believed to provide accurate and supportable information with respect to the subject matter covered. This publication is distributed with the understanding that the Farm Financial Standards Council is not engaged

in rendering accounting, legal, or other professional service. If accounting, legal, or other expert advice and assistance is required,

the services of a competent professional should be sought.

Any act or failure to act, based on the information contained in this publication, would be the sole responsibility of the user.

Copyright 2017 by the Farm Financial Standards Council. All rights reserved.

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INTRODUCTION

The Financial Guidelines for Agriculture (Guidelines), as recommended by the Farm Financial

Standards Council (FFSC), were first released in 1991. Since that time, there have been additions,

revisions and clarifications to the Guidelines, as well as creation of a website and continuous

sponsorship of an annual meeting that addresses timely and relevant financial reporting along with

analysis topics related to agriculture. In addition, numerous presentations have been given to a

variety of audiences, and several articles have been published in an array of industry outlets, both

with the intent of increasing awareness and convincing potential users of the benefits from

implementing the Guidelines.

The goal of implementing the Guidelines is to achieve better financial management decision-making

for the farm business. This requires knowing the accurate financial position and performance of the

farm business, and is represented in the construction and analyses of accurate, complete and timely

financial statements. The Guidelines assist towards this end, and this Implementation Guide helps

with implementing those Guidelines. Because this Implementation Guide frequently refers to page

numbers in the Guidelines, users may find it useful to have a copy of the Guidelines available.

REASONS TO IMPLEMENT

There are several reasons to implement the Guidelines:

▪ Improve the accuracy of financial statements used to report financial position and perfor-

mance to benefit management decision-making and, ultimately, enhance profitability in

different agricultural economic cycles.

▪ Improve the accuracy of financial statements prepared for and presented to lenders for the

purpose of attracting and obtaining borrowed funds, and retaining lender relationships during

more challenging periods, regardless of the cause.

▪ Enhance the understanding and knowledge of a farm business, both from a production and

financial perspective, including how the two areas interrelate and impact each other based on

decisions made.

▪ Establish strengths that would set a farm business apart from its peers.

▪ Understand deferred income tax liability for the farm business.

▪ Determine cost of production (used in conjunction with Management Accounting Guidelines

for Agriculture).

▪ Gain a better understanding of financial measures used by lenders to evaluate financial

position and performance, and learn how to calculate and interpret the measures.

Managerial accounting provides more granular accounting information around the actual costs of

production activities needed to run the farm business. It involves more than simply compiling and

recording information needed to prepare taxes. Instead, it includes the preparation of financial

information designed for use by managers and decision-makers inside the farm business (Eskew and

Jenson, 1986). It can demonstrate a producer’s breakeven point (what is necessary to produce at

current price levels to cover expenses), and the impact of actual or proposed investment decisions

(land and equipment). The producer can make better decisions and avoid possible mistakes.

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Those who have implemented the Guidelines have been satisfied with the results as expressed in

testimonials.

"Healthy Futures is adapting the FFSC financial guidelines to assist rural Native

American farmers. The guidelines are invaluable as a template and easy to modify for

individual farm management business training!"

Healthy Futures, Albuquerque, NM

“I have a 3-ring binder with the Farm Financial Standards Council Financial

Guidelines in my car at all times. As an extension educator I’m often faced with, “we

don’t do it that way” or “how do you do that” in programs. A familiarity with the

Financial Guidelines helps me answer questions quickly and with authority.”

Tim Eggers, Field Agricultural Economist

Iowa State University Extension and Outreach

“At some point, you need to put a stake in the ground and see where you are at. All this

is part of managerial accounting. The worst thing you can do is wait for your banker to

tell you they will no longer loan you money to operate and you had no clue.”

Marcie Scott, S Ranch LLC

OBSTACLES TO IMPLEMENTATION

A major obstacle to implementation is often expressed as a question, “How do I get started?” Most

agricultural producers and lenders are already using some system to collect and report financial

information (i.e., farm record books, recordkeeping software programs, etc.) designed to provide

information for two purposes: reporting federal income taxes and securing a loan from a financial

institution. That information is required, at least annually. With some additional information, the

result can be a vastly improved financial reporting program. In addition to the question of how to get

started, there is a second obstacle. Generally, producers are not accountants, and in a cost-benefit

framework, the cost is often considered too high to fully implement the Guidelines. Hence, the FFSC

offers this implementation guide, which guides non-accountants in an abbreviated implementation of

the Guidelines, by applying a checklist approach and discussion of implementation issues. Tools

including stages of implementation and an actual checklist are included in this discussion.

GENERAL OVERVIEW

Generally Accepted Accounting Principles (GAAP) provide the official standards for private-sector

and governmental agencies and the codified practices and procedures of the accounting profession

that provide consistency for accounting transactions and the preparation of the resulting financial

statements (Eskew and Jensen, 1986). Although the FFSC recognizes and strongly endorses GAAP,

agriculture has some unique practices that result in areas of departure from GAAP. Those departures

are specifically addressed in the Guidelines and in this implementation guide.

This implementation guide is intended to assist in implementing the Guidelines, recognizing that

many producers do not have professional training in accounting. As stated on the first page of the

Guidelines, “The Farm Financial Standards Council (FFSC) recommendations are not written to

suggest changes to GAAP; nor should they be construed to serve as a replacement for, or an

alternative to, GAAP. In fact, the FFSC recognizes that financial statements prepared in accordance

with GAAP may be the ultimate goal for agriculture producers. Currently, however, many producers

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do not maintain their financial records according to GAAP. It is for those producers–and the lenders,

educators, and advisors who work with them–that our recommendations on financial reporting are

prepared.” Furthermore, as noted on page I-5 of the Guidelines, in cases where farm businesses do

not have and likely cannot afford to have the internal accounting systems necessary to generate

financial statements in accordance with GAAP, the FFSC believes that the identified alternatives

contained in the Guidelines, if adequately disclosed, still provide information useful for analytical

purposes.

Detailed discussions, including the justifications for various recommendations, are provided

throughout the Guidelines. Rather than repeat those discussions here, interested readers are directed

to those discussions via Guidelines page numbers that are either listed in the guide or designated by

parentheses. The approach is intended to preserve space and to keep the focus of this guide on

implementation issues.

Audience

The intended audience for this guide is non-accountants. Accountants often prepare financial

statements and reports to satisfy not only lenders and tax reporting requirements, but also

management and/or outside parties (investors, non-resident owners, etc.). They have specific

accounting expertise that non-accountants do not have. Therefore, the implementation guide focuses

on non-accountants, who often prepare balance sheets for an agricultural lender as part of a loan

application (using market values to value assets), and who provide their lender with federal income

tax returns to support their farm earnings. Most often cash accounting is used to record income and

expenses for federal income tax reporting.

Implementation Operational Commitments

Agricultural producers considering implementation of the Guidelines will need to make certain

commitments for the resulting financial statements to provide useful information. Those

commitments will often require changes in daily, or at minimum weekly, operating procedures. At a

minimum, those commitments would include the following:

▪ Frequency – Implementation will require monthly (minimum) bookkeeping and review.

▪ When to implement – Implementation will be easiest at the start of a new tax year. Start by

recording inventory balances; costs of seed, chemicals, fertilizers in growing crops; accounts

receivable; accrued expenses; prepaid expenses; etc. on that date.

▪ Software – At a minimum, users should be using a software program for recording

transactions. Accounting software offers significant advantages over other less automated

recordkeeping systems, or even spreadsheet-based records. A double-entry accounting system

is preferable to a single-entry accounting system, even for cash basis accounting, where the

goal is preparing complete and accurate financial statements.

▪ Change standard operating procedures/daily operations – The need to track and record

certain information throughout the entire farm business will require acceptance and a

commitment to implement the Guidelines by not only family members, but also hired

employees.

The above commitments will ensure complete and accurate year-end financial statements and avoid

potentially large reconciliation differences.

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IMPLEMENTATION STAGES

If net income calculated using an accrual-adjusted income statement must equal net income

calculated using double-entry accrual accounting, then the probability for implementation by many

non-accountants will likely decrease dramatically. For non-accountants who do attempt to implement

the Guidelines and have that expectation, they should anticipate a major commitment in terms of

time and learning and in some cases should expect some level of frustration during the process.

However, if some degree of inaccuracy is acceptable, then the probability for implementation will

increase.

Consequently, implementation will be discussed in this guide using four stages that provide a

common evolutionary path along an implementation continuum (see Table 1).

Stage I is no implementation of the Guidelines and would generally be associated with some type of

loan activity. The financial statements consist of market-value balance sheets; most likely, not at the

beginning/end of the tax reporting period, and a cash basis income statement prepared using

information collected solely for tax reporting purposes.

Stage II is the basic implementation stage and involves starting with cash basis income statement

information, often reported using Schedule F and various forms (e.g., 4562, 4797) and prepared for

the federal income tax return and adjusting those cash amounts for changes in such accounts as

inventories, accounts receivable, accrued expenses, etc. reported on beginning and end of year,

market-value balance sheets. Stage II may be the easiest stage of implementation, but it will also

result in the largest reconciliation difference among financial statements at the end of the year.

The major change from Stage I is preparation of an accrual-adjusted income statement. Often

producers question why accrual adjustments are even needed, but one producer addressed that

question in a more persuasive manner than any academic argument when she said, “Why are accrual

adjustments made? What does it do? It puts all the income and expenses for one year in that year to

see what the business is doing. (It) takes prepaid expenses out and puts deferred income in to look at

what actually happened that one year without blending three years into one. There are significant

dollars in and out in one year that there needs to be a point in time to look at.” Marcie Scott, S

Ranch LLC.

With that difference, the usefulness of the income measurement using an accrual-adjusted income

statement is vastly improved and produces a meaningful measure of periodic net income. Please note

that using Schedule F as a source of cash receipts and disbursements may be problematic as the

Schedule F, even when filed on a cash-basis, is not necessarily cash.

Stage II may be an acceptable alternative to a cash basis income statement for some producers and

their lenders. Examples of financial spreadsheets representing Stage II implementation would be

spreadsheets available from several land grant universities (i.e., Iowa State, University of Illinois and

Purdue University). An example cash-to-accrual income statement is illustrated in Appendix A,

which is an adaptation of Figure 5 from Appendix E of the Guidelines.

Stage III is a more advanced stage of implementation that would include internally prepared double-

entry records that result in all four of the recommended financial statements and would be used in

many cash basis farm accounting systems, with accrual adjustments. This implementation stage

would include additional accounts needed for a more complete reconciliation of end-of-year financial

statements. The result will be a reduction for reconciliation to zero, if the farm records are maintained

correctly.

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Table 1. Implementation Continuum

Characteristic

Features Stages

I II III IV Valuation of noncurrent assets

Market (partial-incomplete)

Market Market/selected cost

Both market and cost

Balance sheet dates

Balance sheets not available for begin-ning and end of tax year

Beginning and end of tax year

End of tax year or accounting period, if different

End of tax year or accounting period, if different

Basis of accounting

Cash Cash with accrual-adjusting amounts recorded on the beginning-of-the-year and end-of-the-year balance sheets

Cash recording of revenue and expense transactions with accrual-adjusting entries recorded on ending balance sheet dates

Cash or accrual recording of revenue and expense transactions with accrual-adjusting entries recorded on ending balance sheet dates

Source documents

Cash basis income tax return

Cash basis income tax return; beginning and ending balance sheets

Internal (on-farm) prepared double-entry records of all financial statement accounts (i.e., farm accounting system software programs)

Internal or external (accountant-prepared) double-entry records for all financial statement accounts

Financial statements required

None Beginning-of-tax year balance sheet; end-of tax year balance sheet; accrual-adjusted income statement for tax year

End-of-year balance sheet; accrual-adjusted income statement; statement of owner equity; statement of cash flows

End-of-accounting period balance sheet; accrual-adjusted income statement; statement of owner equity; statement of cash flows

Financial statements prepared in conformity with the Guidelines

N/A Minimal Partial adoption of Financial Guidelines, including a set of key financial statements

Extensive adoption of Financial Guidelines, including a complete set of financial statements

Financial statements reconcile

N/A Reconciliation differences inevitable

Reconciliation differences should be zero if farm records are maintained properly

Only zero reconciliation difference is acceptable

Usefulness Limited information about farm financial performance

Useful income statement and balance sheet measures for small added cost in time and effort; but yields an incomplete financial picture for which the accuracy is questionable

Complete, and more accurate, financial statements, but consistency from year to year and comparability to similar farms is questionable

Complete, accurate, consistent, and comparable to similar farms that prepare financial statements in conformity with Financial Guidelines

Stage IV would occur with total implementation of all the recommendations in the Guidelines and

result in both market and cost basis balance sheets and a double-entry accrual-adjusted accounting

system. The ultimate goal would result in a zero reconciliation difference.

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Managerial accounting guidelines, along with four stages of implementation specific to managerial

accounting are available in the FFSC Management Accounting Guidelines for Agriculture. That

publication provides specific guidelines as related to accounting information captured, stored, and

reported for that purpose.

Degree of Accuracy Tradeoff

Not all users will likely implement all the recommendations provided in the Guidelines, which will

result in reconciliation differences of varying amounts along the implementation continuum. The

suggestions herein are provided to minimize those differences. Moreover, implementation of the

Guidelines will be influenced by features inherent to using the base documents mentioned above,

which may be inaccurate and, in some cases, incomplete. The likelihood of inaccuracy has been

acknowledged since origination of the FFSC, with departures from Generally Accepted Accounting

Principles (GAAP) noted on pages II-2 through II-5 of the Guidelines.

Hence, a major implementation issue relates to what is an acceptable degree of inaccuracy for the

financial statements, particularly an accrual-adjusted income statement. Stage I implementation

would use incomplete cash receipts and disbursements collected for federal income tax reporting

purposes combined with inaccurate or incomplete market-value balance sheets as underlying

documents from which to prepare the accrual-adjusted income statement; the result would likely be

the largest reconciliation difference. Whereas, Stage III implementation would likely involve an

accountant, but would likely result in a zero reconciliation difference.

A SYSTEM OF FINANCIAL STATEMENTS

“The FFSC identifies financial statements to include: balance sheet, income statement, statement of

cash flows, and statement of owner equity” (II-6). Furthermore, “Financial statements should be

prepared on a consistent basis (i.e., the income statement, statement of cash flows, and statement of

owner equity cover the identical time period and the balance sheet provides values for the beginning

and end of that period)” (II-6).

Consequently, the interrelationships of the financial statements dictate the statements reconcile, with

any differences often accumulating in the amount withdrawn for family living reported on the

statement of owner equity and the ending cash balance reported on the statement of cash flows. In

instances in which amounts calculated do not equal amounts reported on the beginning and end-of-

year balance sheets, much of the inaccuracy can be traced to the underlying information used to

complete the statements, which is often caused by four major implementation issues discussed below.

One major issue is that borrowers who have not implemented the Guidelines do not prepare their

balance sheets “as of” the first and last day of the accounting period, which for many farm businesses

is the calendar year. Instead, their balance sheets reflect “as of” the date they apply for or renew their

loan. Therefore, the first major implementation issue is that beginning and end-of-year balance sheets

for the business must be prepared “as of” the first and last days of the tax reporting period (II-6),

which in most cases is a calendar year. For some producers who borrow money, balance sheets may

be prepared “as of” beginning and end-of-year for the tax reporting period and when submitting a

loan application to a lender.

Second, for retained capital reported on the statement of owner equity to reconcile for beginning and

end-of-year balance sheets, it is recommended that certain capital assets be valued at net book value

(II-10, II-12-13), which will be discussed in detail in the section on the balance sheet in this guide. In

practice, for many non-accountant agricultural preparers, those assets are valued at market values.

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The recommendation will require preparers to determine and report net book values for specified

capital assets to reduce the retained capital reconciliation difference.

Third, when information reported on balance sheets prepared “as of” the beginning and end-of-year

is combined with cash revenue, cash expenses, and depreciation expense, the major components are

available to convert net income calculated on a cash basis to net income calculated on an accrual-

adjusted basis (A-10). However, all the information needed for an accurate reconciliation of retained

capital may not be available (i.e., gains and losses on the sale of capital assets, etc.). The adjustment

procedure is outlined on page E-3. Examples of a cash basis income statement and an accrual-

adjusted income statement are presented in the Guidelines (E-8 and E-9). Appendix E of the

Guidelines provides a detailed discussion of the information needed to convert cash to accrual-

adjusted.

Fourth, once an accrual-adjusted income statement has been prepared, it can then be combined with

the amount withdrawn for labor and management (i.e., withdrawals for family living for sole

proprietorships), non-farm income contributed to the farm business, other capital contributions, gifts

(received or made), inheritances and distributions to calculate change in retained capital on the

statement of owner equity (A-12). Often the amount withdrawn for family living is either unknown

or is the result of some unsubstantiated, often vague, estimate. Since an inaccurate accrual-adjusted

net income is combined with an inaccurate estimate of the amount withdrawn for labor and

management, an accurate reconciliation of retained capital on the statement of owner equity is

impossible, resulting in some degree of inaccuracy.

An example set of the four recommended financial statements including beginning and end-of-year

balance sheets, accrual-adjusted income statement, statement of cash flows, and statement of owner

equity is provided in Appendix A of the Guidelines (A-2 through A-12). Additional information is

needed on net book value for depreciable capital assets (A-9), cost and market values for specified

capital assets (II-13), as well as other information (A-10 and A-11). The interrelationships of the four

statements, the importance of calculating net income on an accrual-adjusted basis, and the need to

provide an accurate estimate of the amount withdrawn for family living are clearly illustrated (A-10

through A-11).

Finally, a question often asked when considering implementation is, “Why is the projected cash flow

statement omitted from the list of recommended financial statements?” The projected cash flow

statement is viewed by the FFSC as a budgeting tool used to project and manage liquidity of the

business in the future. Hence, it is termed a “cash budget.” It is not included as a financial statement

used to report the historical financial position and performance. The list included in the Guidelines is

the minimum set. So, omission of the cash budget should not be interpreted as meaning it is not

useful; instead, it should be viewed as an additional statement that supplements the four

recommended statements.

BALANCE SHEET

Format

This section assumes a basic understanding of the organization and preparation of a balance sheet, so

the discussion focuses on implementation issues. A specific format for the balance sheet is not

recommended by the FFSC (II-8), but there are recommendations related to the entity for which the

balance sheet is prepared (II- 9 and I-10), materiality (II-8 and Appendix I), valuation methods (II-12

and I-13) and recording specific assets (i.e., growing crops) (II-2 through I-5). Several specific

recommendations that directly affect implementation for many agricultural producers, but not

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discussed in detail above (i.e., “as of” dates for the beginning and end-of-year balance sheets) are

discussed in the following sections.

Asset and Liability Classification

In the Guidelines, it is recommended assets and liabilities be classified into current and non-current.

The recommendation presents an implementation issue for some non-accountant preparers, since the

more widely used practice in agriculture is to use three classes; current, intermediate and long-term.

One practical way to address the issue is to report intermediate and long-term assets and liabilities as

sub-classes of the non-current class.

The classification issue is discussed in detail in the Guidelines. A specific section on Classification of

Current Assets and Current Liabilities is provided on pages II-41 and II-42, with recommendations

provided for several specified assets. In addition, at a minimum, the balance sheet should separately

identify four categories of non-current assets: machinery and equipment, breeding livestock, buildings

and improvements, and land (II-9 and II-10). Likewise, non-current liabilities should separately

identify two categories: real estate debt and notes payable, other than real estate debt (II-9).

Asset Valuation

The recommendation to report both cost and market values on a balance sheet presents an

implementation issue, since the more common, traditional practice in agriculture is to value all assets

using market values. However, both cost and fair market values are recommended for capital assets

(II-12 and II-13), which can be disclosed on the face of the balance sheet with parenthetical, footnote,

or supporting schedule disclosure of cost and accumulated depreciation amounts, or by utilizing a

double-column approach (II-10). Valuation recommendations for many assets common to agriculture

are provided on page II-11, with example balance sheets using cost and fair market values, using

supporting schedule disclosure (A-2 through A-9).

Inventories

Reporting inventory quantities in the appropriate category on a balance sheet is an implementation

issue for some farm businesses since some grain producers sell grain produced and others feed grain

produced to livestock and some producers do both. A detailed discussion on inventories other than

breeding livestock is provided (II- 25 through II-28), including specific recommendations on

inventories raised/harvested for sale, inventories raised/harvested to be used in the production

process, inventories purchased for resale, and inventories purchased for use in the production

process.

In addition, many livestock producers need to report inventories of breeding livestock, both raised

and purchased. A detailed discussion on reporting and valuing raised breeding livestock, including

the calculation and use of base value, is provided (II-36 through II-38). The valuation of purchased

breeding livestock is discussed on page II-38.

Hedging

For many farm businesses, hedging is an integral part of the marketing plan and is one of the tools

used to manage market risk. Properly reporting equity in the hedge accounts often presents an

implementation challenge for many non-accountants. The types of hedges (i.e., fair value and cash

flow) and the recommended approaches for recording and reporting hedge accounts are provided (II-

28 through II-34). Detailed hedging examples for both grain and livestock, including tax treatment,

are provided in Appendix H of the Guidelines.

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Perennial Crops

Perennial crops present an implementation issue because the costs associated with the establishment

and production of those crops normally span multiple years, which results in reporting issues for both

the balance sheet and the income statement. The implementation issue relates to the identification,

collection, allocation and reporting of development versus production costs. Recommendations on how

to report both development and production costs for perennial crops are provided (II-40 and II-41).

Government Loan Programs

Government loan programs have been, at various times throughout history, widely used across U.S.

agriculture. Since users of government loans have the option of either repaying the loan plus interest

or forfeiting the crop to the Commodity Credit Corporation and keeping the loan proceeds with no

interest charged, reporting issues arise. A discussion of the three basic approaches to reporting

government loans is provided (II-41) along with the FFSC recommendation.

Depreciation

An implementation issue that surfaces frequently is the method used for depreciation of depreciable

capital assets, specifically book depreciation versus tax depreciation. Tax depreciation methods,

which are oftentimes highly accelerated in the year of purchase, are generally not a suitable basis for

establishing depreciation expense reported on an income statement because they result in significant

understatements of net income in years of major purchases and may cause significant swings in

depreciation expense and net income from year to year. Depreciation is subject to several different

calculation approaches. These approaches are discussed in detail in the Guidelines, along with the

advantages and disadvantages of each (II-23 through II-25). The conclusions and recommendations

of the FFSC regarding depreciation are provided (II-25) and are listed below.

1. The FFSC encourages producers to adopt book depreciation methods with appropriate useful

lives and salvage values for the most accurate allocation of the purchase price of a

depreciable asset over its useful life.

2. Depreciation expense is a significant component of total expense on most farm operations,

and it is important that it be treated in a manner that will provide results that are as consistent

as possible and that allow for reasonable comparative analysis. No depreciation method is

perfect, and it is important to note that depreciation is a method of allocation, not of

valuation. Generally, methods, which follow the “market-based” approach (II-24) will not

result in numbers that are consistent or comparable and should not be used.

3. Depreciation expensing for specific assets may change as business plans change for the

useful life and/or the expected salvage value of the asset.

4. The depreciation method utilized in preparing the financial statements should be clearly

disclosed, either by identifying the method or by including supplementary schedules detailing

the calculation.

An example of how to record and report book value depreciation is provided (A-9).

Capital Leases

Capital leases have become more widely used in agriculture due to the specialization and size of

some items of machinery and equipment as well as some facilities. For agricultural lenders,

implementation issues arise particularly for the balance sheet and portrayal of financial condition.

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Failure to report capital lease obligations on the balance sheet misrepresents the solvency position of

the business. In addition, failure to accurately classify lease obligations into current and non-current

classes misrepresents the liquidity position of the business. Reporting capital lease obligations only

as liabilities and omitting an offsetting position on the asset side of the balance sheet adversely

affects owner equity. Recommendations on how to report capital leases for credit analysis purposes

are provided (II-40). A detailed example is provided in Appendix G of the Guidelines.

Cooperatives

Cooperatives are used widely in agriculture as input suppliers, marketing outlets, and as service

providers. Consequently, many agricultural producers own equity in cooperatives in the form of

membership certificates. The certificates are not traded on open exchanges, so reporting issues arise

as to how to both classify and value the certificates on the balance sheet. The FFSC

recommendations are provided (II-39 and II-40).

Taxes, including Deferred Taxes

Every business faces the issue of reporting accrued taxes on the balance sheet. That issue is

compounded in agriculture when market values are used to report assets on a balance sheet. That

practice results in the creation of deferred tax liabilities that are contingent upon the sale of the

assets. In practice, most farm businesses simply ignore that contingent liability, while including all

the valuation equity, which misrepresents the equity position of the business. Implementation issues

arise for both calculating and reporting deferred taxes on the balance sheet. The issue is discussed in

detail (II-18 through II-23), along with a step-by-step procedure that can be used to calculate deferred

taxes on values assigned to respective assets.

Personal Assets/Liabilities and Non-Farm Income

Many farm businesses still retain characteristics of a small, sole proprietor, family-operated business,

and do not fully segregate business and personal assets, liabilities and non-farm income. A common

example is the personal residence, which is often included as part of the farmstead. Hence, the

farmstead would include business assets such as machinery sheds, grain storage, etc. as well as the

personal residence. The FFSC states it is preferable to have separate financial statements for business

and personal, but acknowledges that in certain cases, particularly involving smaller operations,

combined business and personal statements will continue to be used (II-14). This lack of segregation

and the related recommendations regarding the balance sheet, income statement and statement of

owner equity are discussed (II-13 and II-14). An example of how to report personal assets and

liabilities on the balance sheet and the statement of owner equity is provided (A-2 and A-12).

INCOME STATEMENT

The Guidelines acknowledge the existence and imply the use of other financial reporting programs to

prepare an accrual-adjusted income statement by stating in the definition “…incorporating into the

cash basis numbers the changes to accounts receivable, inventories, prepaid expenses, raised

breeding livestock, accounts payable, accrued liabilities, deferred income taxes and other accrual

amounts not otherwise recorded in the cash basis…” (Glossary-2). The major causes of inaccuracy

associated with an accrual-adjusted income statement were discussed in the section entitled “System

of Financial Statements” and will not be repeated here.

An often-asked question is, “How much difference is there between net incomes calculated using

cash versus accrual-adjusted income statements?” The magnitude of that difference is provided by a

study of Illinois producers (Barnard, Ellinger, & Wilson, 2010), which found the difference between

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Net Farm Income calculated using a cash income statement versus an accrual-adjusted income

statement was 66 percent (IV-6). Another study discussed on page E-2 of the Guidelines found, an 85

percent average annual difference in net farm income when measured on an accrual adjusted basis

versus a cash basis.

The essential pieces of financial information needed to prepare an accrual-adjusted income statement

are cash receipts and disbursements and the annual depreciation allowance, as well as beginning and

end-of-year balance sheets. When an approximation of net income using an accrual-adjusted income

statement is acceptable, these amounts can be transferred directly from the internal accounting

system documents needed to prepare the federal income tax return. Appendix E of the Guidelines

provides examples and identifies specific accounts needed to make the accrual adjustments needed to

make the conversion.

WITHDRAWALS FOR FAMILY LIVING

Examples of the statements of owner equity and cash flows are provided in Appendix A of the

Guidelines (A-11 and 12). A key piece of information needed for reconciliation of the owner equity

and cash accounts for both statements is the amount for unpaid labor and management. The FFSC

acknowledged in the 1991 Report, that in many cases, it would be reasonable to utilize the amount of

family living withdrawals as an estimate of the value of unpaid labor and management (II-17).

However, that amount is often unavailable for many farm businesses, because most do not keep

detailed records on family living expenditures. Since a number is needed for the cash and retained

capital accounts to reconcile beginning and end-of-the year balance sheets in an interrelated system,

an estimate is often used. That estimate can range from an admittedly inaccurate, but somewhat

informed, estimate to an outright guess.

When no estimate is provided and the two statements are prepared, the amount needed to reconcile

each statement can range from an unrealistically small amount to a number that implies a level of

extravagance that most producers typically deny. Of course, the desired approach is to record each

amount withdrawn for family living expenditures and to assign that amount in a family living

expenditure category. However, most producers are not willing to devote the time needed to record

such detail. The challenge for those considering implementation of the Guidelines is how to provide a

realistic amount for family living withdrawals without being overly burdensome.

A practical approach that is limited in the ability to provide useful information on individual personal

expenditures, but one that does provide a more accurate estimate of the amount withdrawn is to have

two separate checking accounts. One account is used exclusively for the farm business and the

second is used exclusively for personal expenditures. An amount is withdrawn periodically (i.e.,

monthly) from the business account and deposited in the personal account. At the end of the year, the

checking account balances reported at the beginning and end of the year are reconciled with the

summation of amounts transferred throughout the year to calculate an estimate of family living

expenditures.

It is essential that payments for personal expenditures be made only from the personal account, with

additions into the account transferred from the business account or deposited from off-farm income.

No family living or personal expenditures should be paid from the business account. Likewise, no

business expenditures should be paid from the personal account. Also, the producer should never take

cash for pocket money out of deposits of farm business income. If the producer maintains a savings

account, always deposit farm business income in the farm business checking account, and then

transfer it out to the savings account rather than initially depositing the income directly into the

savings account.

October 2017 14

FINANCIAL ANALYSIS AND BENCHMARKING

Financial Criteria and Measures

Financial measures included in the Guidelines are not intended to be all-inclusive, but do provide a

framework from which to conduct financial analysis for a farm business (II-1). A discussion of the

financial criteria and each financial measure recommended, as well as the calculations and

limitations of each is provided in the Guidelines (III-1 through III-24). Those discussions will not be

repeated here, but potential users of the Guidelines should review those calculations and ensure they

use financial information prepared in accordance with the recommendations of the FFSC when

calculating the measures (i.e., accrual-adjusted versus cash income statements). Spending time

analyzing the financial statement measures and the recommended ratios is the key to achieving the

full benefits of implementation. Do not stop with one year’s results. The information becomes more

valuable as more years of results are added and trends in financial position and performance emerge.

Recommendations on how to use financial information are provided (IV-1 through IV-11). Example

calculations using the example financial statements provided in Appendix A are provided in

Appendix C.

Benchmarking

As stated on page IV-12, benchmarking can be used to help evaluate financial position and

performance to improve decisions, but attention is needed to ensure comparability of the data to the

farm business. Useful information for many potential users of the Guidelines is the source and

availability of comparative data that can be used for benchmarking. The Guidelines discuss several

issues to consider when selecting a source for benchmarking, including selection of financial

benchmarks (IV-3 and IV-4), comparability from an accounting perspective (IV-4 and IV-5),

accounting methods (IV-5 through IV-6), business characteristics (IV-6 through IV-8) and financial

data stratification (IV-8 through IV-10). Several state farm and ranch record-keeping programs

provide summaries of comparative data collected and analyzed (i.e., Illinois, Kansas, Kentucky,

Minnesota, etc.). An example of the financial benchmarks published by the Center for Farm Financial

Management (https://www.cffm.umn.edu) is provided (IV-9 and IV-10).

FINAL COMMENT

Implementation of the Guidelines often means different things to different users. To address that, an

implementation continuum is used to present the stages of implementation and the reporting require-

ments needed as one moves along the continuum. The reporting requirements are summarized into an

Implementation Checklist in Appendix B in this document. The checklist enables users to assess the

information needed at the various stages of implementation as well as the benefits and costs

associated with moving to each successive stage of implementation.

October 2017 15

References

Barnard, F. L., P.N. Ellinger and C. Wilson. (2010). Measurement Issues in Assessing Farm

Profitability through Cash Tax Returns. Journal of the American Society of Farm Management and

Rural Appraisers, 207-217 http://ageconsearch.umn.edu/bitstream/96408/2/334_Barnard.pdf or

http://purl.umn.edu/96408.

“Cash to Accrual Income Approximation”, Fast Tools and Resources. University of Illinois.

http://www.farmdoc.illinois.edu/fasttools/spreadsheets/ProgramDescriptions/CashtoAccrual.pdf.

Center for Farm Financial Management. (2013). FINBIN. St. Paul, Minnesota. Retrieved from

https://finbin.umn.edu/.

Edwards, William. (2016). “Converting Cash to Accrual Net Farm Income”, Ag Decision Maker File

C3-26. Iowa State University Extension and Outreach. http://www.extension.iastate.edu/agdm/

wholefarm/html/c3-26.html.

Eskew, Robert K. and Daniel L. Jensen. Financial Accounting, second edition. Random House

Business Division. New York: 1986.

Farm Financial Standards Council. 2017. Financial Guidelines for Agricultural Producers:

Recommendations of the Farm Financial Standards Council (Revised).

http://www.ffsc.org/index.php/order-the-guidelines/.

Miller, Alan, Craig Dobbins, Michael Boehlje, Freddie Barnard, and Nicole Olynk. Farm Business

Management for the 21st Century: Measuring and Analyzing Farm Financial Performance. Purdue

University Publication EC-712. https://www.extension.purdue.edu/extmedia/ec/ec-712-w.pdf.

October 2017 16

APPENDIX A: EXAMPLE OF CASH-TO-ACCRUAL INCOME STATEMENT

Income Statement, Accrual-Adjusted Basis Farm Operation Name For the Year Ended, 12/31/X6

Revenues Notes

a Cash Receipts from Grain Sales Cash Receipts1

b Change in Grain Inventory Ending less Beginning B/S value

c Cash Receipts from Market Livestock Sales Cash Receipts1

d Change in Market Livestock Inventory Ending less Beginning B/S value

e Cash Government Program Payments Cash Receipts1

f Other Cash Receipts Cash Receipts1

g Change in Accounts Receivable Ending less Beginning B/S value h Gross Revenues (a + b + c + d + e + f + g)

Expenses

i Cash Disbursements for Operating Expenses Cash Disbursements2

j Change in Accounts Payable Ending less Beginning B/S value k Change in Prepaid Expenses Beginning less Ending B/S value l Change in Unused Supplies Beginning less Ending B/S value m Change in Investments in Growing Crops Beginning less Ending B/S value

n Depreciation3/Amortization

o Total Operating Expenses (i + j + k + l + m + n)

p Income from Operations (h – o)

Other Revenues (Expenses)

q Dividend/Interest Income

r Gain/Loss on Sale of Farm Capital Assets4

Interest Expense

s Cash Paid for Interest Cash Disbursements2

t Change in Accrued Interest Ending less Beginning B/S value u Total Interest Expense (s + t)

v Miscellaneous Expense w Total Other Revenues (Expenses) (q + r – u – v)

x Income before Income Taxes (Net Farm Income) (p + w)

Income Tax Expense

y Income & Self-Employment Taxes Paid Cash Disbursements2

z Change in Income & Self-Employment Taxes Payable Ending less Beginning B/S value aa Changes in Current Portion of Deferred Taxes Ending less Beginning B/S value ab Total Income Tax Expense (y + z + aa)

ac Net Income, Accrual-Adjusted (x – ab)

1Cash receipts received during the year. If using the Schedule F as a source of cash-basis information, keep in mind that some Schedule F items may not be cash such as deferred sales contracts, CCC loans, fuel tax credits, patronage dividends, etc. Necessary for measurement of accrual-adjusted net income is the actual cash received during the period.

2Cash disbursements paid during the year. If using the Schedule F as a source of cash-basis information, again keep in mind that some Schedule F items may not be cash such as purchases of feeder livestock, pension & profit-sharing plans, employee benefits, etc. The actual cash paid during the year is the amount needed on this form.

3Should be based on book depreciation. If tax depreciation is used, note that net income may be understated due to accelerated depreciation methods.

4The gain/loss on sale should be determined based on the difference between sales price and the book value of the asset sold. Assistance may be necessary to determine the cost-basis of sold assets.

October 2017 17

APPENDIX B: IMPLEMENTATION CHECKLIST

Stage I

Cash basis tax return, partial (incomplete) market value balance sheet.

Stage II

Beginning and end-of-year balance sheets prepared at the start and end of the fiscal year,

usually a calendar year.

Market values reported for business assets, supplemented with cost values for:

marketable securities

breeding livestock

machinery and equipment

real estate

Personal assets and liabilities reported separately from business assets, including the

residence.

Cash receipts and disbursements (generally the source information for tax preparation) or

Schedule F of the federal income tax return.

Sales of business assets such as breeding livestock, machinery, equipment, etc. or Form

4797 of the federal income tax return.

Purchases of business assets such as breeding livestock, machinery, equipment, land,

buildings, improvements, etc.; some evidence of this information may be on Form 4562 of

the federal income tax return.

Separate personal and business checking accounts, and family living expenses paid

exclusively from the personal checking account.

Stage III

All assets reported using both market and cost basis valuation methods.

Deferred tax liabilities reported in conjunction with market value asset values.

Stage IV

Chart of accounts needed to prepare a balance sheet using the cost basis valuation method.

Chart of accounts needed to prepare an income statement using double-entry accrual

accounting.